Ukraine’s Debt to Russia: Detonator for Global Financial Chaos?

TND Guest Contributor: Valentin Katasonov |

The $3-billion loan Russia provided to Ukraine in December of 2013 will mature in a month and a half. Kiev has made the decision to overlook what it owes to Russia. Such daring, or perhaps it should be called audacity, can be explained by the fact that the Ukrainian government senses that it has the support of Washington. And the US is even working to get Kiev’s financial chicanery blessed by the IMF.

According to the National Bank of Ukraine, that country’s international reserves now amount to about $13 billion. Kiev has the ability to pay – just not the desire. But even if Kiev did not have that $13 billion, it could get the $3 billion it needs to pay Moscow, from that very same IMF. As long as Ukraine is not in full-fledged default, the IMF can send Kiev the next scheduled tranche of its bailout loan under the current agreement that was signed in the spring of 2015. The fact that this option is not being discussed shows once again that Washington is not looking for a simple solution. It needs to muddy the waters as much as possible.

With manic energy, the US is mounting an assault on the International Monetary Fund, demanding an urgent review of the rules of lending, so that the altered rules will allow Kiev to forgo paying its debt to Moscow at the end of the year without painful repercussions. But if Kiev refuses to pay, this will only precipitate a financial crisis. And not just in Ukraine, but all over the world. I’m not kidding.

If, as the result of backroom manipulations (“rule changes”), the IMF endorses Kiev’s position and rules that Ukraine’s debt to Russia is not an “official,” government-to-government loan, but rather a private one, then this would seem to be in Kiev’s interest. A refusal to repay private (commercial) debt would be considered only a partial default, which would not prevent the IMF from continuing to transfer loan funds to Ukraine. But in that event Russia would have a wide range of retaliatory measures to choose from. I will list only two.

The first option. Filing a claim with the British court system (either an ordinary court or one specifically for international arbitration). The 2013 loan agreement stipulates that any disputes between the parties are to be reviewed in the courts of the United Kingdom in accordance with British law. Moscow’s lawsuit must challenge Kiev’s actions and demand confirmation that the Russian loan falls under the category of “official” debt. Experts believe that any ruling by the British court (assuming politics do not intervene) would be unequivocal: the debt is official.

The second option. Agreeing that the loan to Ukraine falls under the category of private (“commercial”) debt. And using the court to demand that Kiev repay 100% of the debt. That would produce an interesting situation. Kiev has happily reported that its debt to its creditors has been successfully restructured. Twenty percent of the debt has been written off, the repayment deadlines have been extended, and the interest rate has been raised. Kiev claimed that the creditors holding 75% of its private debt attended the final negotiations in London where the agreement was reached. Those who hold the remaining 25% of the private debt being restructured did not participate. The Ukrainian government places Russia – to which about 17% of the private debt is owed, according to the Ukrainians’ calculations – within this 25%. The financial markets have seen many recent cases of debt restructuring, but, as a rule, the creditors holding over 90% of the debt have been involved. But there are no guarantees, even with such a high figure.

It’s likely that in other eras one might have expected some comments or even official statements from the International Monetary Fund over what Kiev has stridently called its debt “restructuring”. In fact this is nothing but blasphemy, of which IMF staffers are well aware, but they are silent. Russia should not sit silently, but act. If in the last ten years creditors holding merely 7-8% of Argentina’s debt (and they were speculators and financial raiders) were able to force a review of the restructuring of Argentina’s enormous debt, then Russia has far more justification to do so with regard to Ukraine’s debt.

This is, first of all, because in contrast to those financial vultures, Russia is a bona fide creditor.  Russia did not buy “junk” on the secondary market. The deal was a placement of 100% Ukrainian debt securities, sold on the Irish Stock Exchange, issued at par, and with a coupon rate that had been reduced by more than 50%.

Second, even if we assume that Ukraine’s debt to Russia is private, Russia holds about 17% of all of Ukraine’s private debt, as mentioned above. That is a very significant stake.

Third, it was extremely difficult to force the private creditors, who spent the entire summer of 2015 at the negotiating table, to write off part of Ukraine’s debt (20% of the principal).  According to our sources, the negotiations with Kiev were led by some hard-boiled financial vultures (chief among them – Franklin Templeton). They were forced to agree to a meal of cabbage instead of red meat. Therefore, the private creditors can at any time disavow the agreement reached in London to write off part of the debt. And Moscow can provide them with the warrant to do this, with its demand through the English courts for 100% repayment of the Eurobond debt. A game called “Ukraine’s debt to Russia is private” could be a real nail-biter.

It is said that the IMF sees the trap into which Ukraine could fall if its debt is deemed private. Experts who are carefully following the uproar over Ukraine’s debt tend to think that the IMF is still unlikely to change the status of Kiev’s debt to Moscow. Instead, it will probably be decided that just because an IMF member is declared to be in default on an “official” debt to a particular government, this does not affect the fund’s ability to lend to the country that has been declared to be in such “partial” default.

If the IMF does come to this decision, it will be extremely difficult to predict the consequences. The mind boggles. Such a decision would cast aside a rule that has been in force throughout the fund’s history – that sovereign debt is a sacred cow. Any attempt to butcher this “cow” would make that state a pariah in the system of international finance. The slaughter of this sacred cow, scheduled for late November, will lead to a total paralysis of the IMF’s work and the disappearance of what are now known as sovereign loans and credits, just as the mammoths and dinosaurs vanished so long ago.

The radius of the disruption that would occur as a result of Ukraine’s refusal to pay its debt to Russia will spread very far. And Russia will also suffer, but if it plays its hand carefully it will be able to get its money back. But there will be many losers.

First of all, Ukraine. Ukraine’s refusal to pay its debt, even if it gets the next tranche from the IMF in violation of the current rules, will only prolong the throes of Kiev’s financial death. In my estimation, it will only delay the inevitable by a few months.

Second, the International Monetary Fund. During its six months of working with Ukraine, it has broken all the rules that had been formulated and fine-tuned over the course of decades. All the transgressions and chicanery that the IMF has allowed itself when dealing with Ukraine are being piled on top of the fund’s own reform crisis, now in its fifth year. The IMF will celebrate its 70th birthday in late December 2015, but it seems to me that the star of the party will not be around too long after the big day.

Third, the nations of continental Europe. Because Washington is forcing its allies to accept political decisions being made at the IMF in favor of Ukraine and in violation of the current rules, their reputation will be seriously affected. After all, the board of directors will vote on the decision to change the fund’s rules, with the support of America’s European allies. And it seems they have nowhere to turn. Madame Christine Lagarde, the fund’s managing director, claimed at the last IMF-World Bank annual meeting in Lima (Peru) that she is willing to “belly-dance” for Washington, if only the US Congress will vote to ratify the IMF’s decision to review the quotas. Paris deemed that offer inappropriate, reminding Madame Lagarde that she is not only an international official, but also a representative of France.

Fourth, Great Britain. London is already nervous, because it is in the British court system where the showdown over the ill-fated debt will begin. The loan agreement between Russia and Ukraine stipulates that British law be used to resolve any dispute. Many experts anticipate that Washington will insist that London make the “correct” ruling. London’s reputation as a center for international arbitration could be on the line. If London caves in, new issues of Eurobonds will look to other courts for guidance.

Fifth, the entire world. International financial transactions, such as issuing sovereign loans and credits, could be paralyzed. We could witness a parade of states defaulting on their sovereign debt. Innocuous “partial” defaults could mushroom into full-fledged ones. The second wave of the global financial crisis would begin. It seems that the US is pursuing the matter in order to use Ukraine’s debt to Russia as a detonator for global financial chaos.

Valentin Katasonov, D.Sc. (Economics), Economist and the chairman of the S.F. Sharapov Russian Economic Society

This work was published at the Strategic Culture Foundation on-line journal www.strategic-culture.org and is reprinted with permission.